a2 Milk Company Ltd (Australia): Is it boom to bust for baby formula?

Is the infant formula boom on hold?

Analysts at Citi appear to think it could be. According to a research note this morning the investment bank has initiated coverage on a2 Milk Company Ltd (Australia) (ASX: A2M) with a sell rating.

Following disappointing news regarding the Blackmores Limited (ASX: BKL) and Bega Cheese Ltd (ASX: BGA) joint venture, Citi is expecting the next 12 months to be challenging for infant formula sellers in the China market.

In light of this a2 Milk Company’s share price has dropped around 4% to $1.84. So should you join the herd and sell your shares as well?

Whilst negative sentiment could of course send the share price lower still, I wouldn’t be in a rush to sell up just yet.

So far we’ve only heard one side of the story. Both a2 Milk Company and Bellamy’s Australia Ltd (ASX: BAL) had strong finishes to FY 2016, especially in the China market. And both companies not only grew sales at an incredible rate, but they also developed a strong premium brand image in the country.

I was quite impressed with last week’s AGM presentation from Bellamy’s. Management appeared bullish on the year ahead and I would have expected the company to advise of any deterioration in market conditions at that point if there were any.

So for now I would look at the sell-off in both of their respective shares as an opportunity to invest. I personally have a preference for Bellamy’s over a2 Milk Company based largely on valuation.

Currently a2 Milk Company’s shares are changing hands at 23x estimated FY 2017’s earnings, whereas Bellamy’s are available for just 17x estimated FY 2017’s earnings. At this level Bellamy’s looks like a screaming buy in my opinion, just as long as it can live up to the market’s expectations.

I personally expect it will do, so for this reason I consider Bellamy’s a buy and a2M Milk Company a hold.

Whilst I don't think you should sell a2 Milk or Bellamy's, I do think you should consider selling these wealth destroying shares today. Do you own them?

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Motley Fool contributor James Mickleboro has no position in any stocks mentioned. The Motley Fool Australia owns shares of A2 Milk and Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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